## Facts

- The American Academy of Family Physicians (Academy) is a national professional association exempt from federal income tax as a § 501(c)(6) business league.
- The Academy sponsored group disability, medical, and life insurance plans for members and their employees; the policies were underwritten by a commercial insurer, Principal Mutual Life Insurance Company (Principal).
- The Academy’s charitable affiliate (the Foundation) was exempt under § 501(c)(3) and owned AAFP Insurance Services, Inc. (ISI), a for-profit corporation that administered the insurance plans, paid federal income tax on its profits, and paid dividends to the Foundation.
- Members paid premiums to Principal; Principal maintained reserves from premiums to pay future claims and controlled investment of those reserves.
- Under the policy arrangements, Principal made annual payments to the Academy calculated as a fixed percentage of the reserves (described as payments for Principal’s use of the reserves), regardless of whether the plans were profitable to Principal.
- The policies also provided that after termination of the policies and payment of all claims, any remaining reserve funds would be remitted to the Academy.
- The Academy treated Principal’s annual reserve-based payments as part of its exempt operations and did not report them as taxable income.
- The IRS determined the payments were unrelated business taxable income (UBTI) under the unrelated business income tax (UBIT) provisions, assessed tax, and the Academy paid and sued for a refund.
- The district court entered judgment for the Academy; the United States appealed.

## Issues

1. Whether the annual reserve-based payments from Principal to the Academy constituted UBTI under 26 U.S.C. § 512(a)(1) as income from a trade or business regularly carried on that was not substantially related to the Academy’s § 501(c)(6) exempt purposes.
2. Whether the payments were properly characterized as investment-like or commercial income from exploitation of insurance reserves, rather than consideration connected to the Academy’s member-service insurance sponsorship.

## Decision

- The Eighth Circuit affirmed the district court’s judgment for the Academy.
- The court held the reserve-based annual payments were not taxable as UBTI to the Academy.
- The Academy was entitled to a refund of the taxes paid on those payments.

## Legal Principles

- UBTI generally includes income from a “trade or business” that is “regularly carried on” and “not substantially related” to an exempt organization’s purposes, aside from generating funds. 26 U.S.C. § 512(a)(1).
- In assessing UBTI, courts examine the character of the organization’s activity and the relationship between the income-producing activity and the organization’s exempt purposes, not merely the presence of revenue.
- Payments received in connection with an exempt organization’s provision of customary member services may fall outside UBTI when the organization does not itself underwrite, invest, or operate the commercial activity generating the underlying funds.
- Where a separate taxable subsidiary earns and pays tax on true administrative profits from a commercial program, that structure supports treating the exempt organization’s more limited receipts as part of its related member-service function rather than unrelated commercial income.

## Conclusion

The Eighth Circuit concluded that the Academy’s sponsorship of member group insurance and receipt of reserve-based payments from the commercial underwriter were sufficiently tied to the Academy’s member-service purpose, and did not constitute unrelated business taxable income under the UBIT provisions.


Am. Acad. of Fam. Physicians v. United States, 91 F.3d 1155 (8th Cir. 1996)